A “fundamental breach” is defined as a breach of contract that deprives the innocent party of “substantially the whole benefit of the contract”. For instance, in a contract for the sale of goods, delivery of goods that were “different in kind from those contracted for” would be a fundamental breach.

The problem with this approach is that sometimes the court would not enforce an Exclusion Clause even though there was no good reason not to in the circumstances. The automatic cancellation of an Exclusion Clause was potentially too inflexible a rule to be just and fair in all cases.

The 1970 English case of Harbutt’s ‘Plasticine’ Ltd. v. Wayne Tank & Pump Co. Ltd. illustrates this. Here the contractor Wayne Tank designed and installed a storage tank and piping system for hot wax that Harbutt’s used in its manufacturing process. Instead of using stainless steel, Wayne Tank used plastic pipe that was not heat resistant. The hot wax ruptured the pipe and spilled out, and burned the factory down.

The court said that using plastic pipe was a fundamental breach on Wayne Tank’s part. The Exemption Clause that specifically limited Wayne Tank’s liability to the contract amount (£2,300) therefore did not apply. Wayne Tank was liable for the whole £170,000 cost to rebuild the factory. In other words, Wayne Tank was liable for damages equal to 74 times its contract price.

In reality, all this meant was that Wayne Tank’s liability insurer had to pay and Harbutt’s fire insurer avoided having to pay a fire damage claim that it had specifically insured. Parties could not rely on Exclusion Clauses to allocate risk and obtain appropriate insurance, because in cases of fundamental breach, the Exclusion Clause would not apply. Thus, both parties would have to obtain insurance, even though the contract was designed to allocate the risk, and necessity for insurance, to one of the two parties.

Because the doctrine of fundamental breach had automatic consequences, it potentially ignored the contractual terms the parties had agreed to, for no good reason.

Hunter Engineering v. Syncrude

In Hunter Engineering Company v. Syncrude Canada Ltd., the Supreme Court of Canada added flexibility to the doctrine of fundamental breach so that Exclusion Clauses would not longer be invalidated in every case of fundamental breach. In this case, Syncrude purchased from two companies, Hunter Engineering and Allis-Chalmers, gearboxes for the conveyers that transported raw tarsands to its extraction plant in Alberta.

Both the Hunter Engineering and Allis-Chalmers contracts warranted the gearboxes for 12 months. Due to a design flaw, the gearboxes failed, but only after the 12-month warranty period had expired. Hunter Engineering was still liable to Syncrude for damages, because in addition to the contract warranty, a 24-month warranty period under the Sale of Goods Act also applied.

However, Allis-Chalmers’ contract said “no other warranty or conditions, statutory or otherwise shall be implied”. This boilerplate clause meant that the 24-month statutory warranty under the Sale of Goods Act did not apply to Allis-Chalmers. Syncrude alleged Allis-Chalmers had fundamentally breached the contract because the gearboxes failed after two years, when they should have lasted for ten, and would cost as much to repair as replace.

The Supreme Court said that, even if there was a fundamental breach, the presumption was that Exclusion Clauses would be enforceable unless there was some legitimate reason not to enforce them. As Madam Justice Wilson said:

A contractual provision that seems unfair to a third party may have been the product of hard bargaining between the parties and, in my view, deserves to be enforced by the courts in accordance with its terms.

In this case, there was no reason not to enforce the Exclusion Clause. Thus Allis-Chalmers was not liable to Syncrude.

The Problems with Hunter Engineering v Syncrude

Unfortunately, the judges in Hunter Engineering did not agree in their analysis as to what test to apply to determine whether or not to enforce an Exclusion Clause. Madam Justice Wilson said the test was whether “it was fair and reasonable to enforce the [Exclusion Clause] in favour of the party who had that committed that breach”.

Chief Justice Dickson wanted to go even further, and “replace the doctrine of fundamental breach with a rule that holds the parties to the terms of their agreement, provided the agreement is not unconscionable”. Traditionally, unconscionability applied to circumstances at the time of contract formation, where unequal bargaining power would incline the court to find it unconscionable to enforce an Exemption Clause against the weaker party.

Subsequent cases have jumbled the two tests together, saying that Exclusion Clauses will be enforced even in cases of fundamental breach unless enforcement would be:

• unconscionable;
• unfair or unreasonable in the circumstances;
• or otherwise contrary to public policy

There are two problems in theory with this test. First, it is too vague: what considerations of public policy would cause a court not to enforce an Exclusion Clause? Secondly, the standards are inconsistent: unfair and unreasonable are much lower thresholds than unconscionable.

Fundamental Breach in Construction Cases

While parties continue to claim fundamental breach in litigation, the court doesn’t often agree, particularly in construction cases. Commonly in construction cases, the potential fundamental breach is not detected until after the work is finished. Thus there hasn’t been a total failure to perform, but merely deficient or late performance, which cannot be said to deprive the innocent party of substantially what it bargained for.

Coscan Development Corp. v. Evercrete Ltd. is a good example of the typical result. Here the defendant Evercrete built in 1980, for $82,000, a concrete acoustic fence between a CN railway line and Coscan’s subdivision in Vaughan, Ontario. Evercrete provided a two-year warranty. In 1986, the fence started to deteriorate, and was taken down and replaced in 1990 at a cost of $210,000. Nevertheless, the trial judge concluded:

Coscan has not been deprived of substantially the whole contract. The Evercrete fence was completely functional and had not begun to deteriorate until six years after it was installed. It was, therefore, fulfilling its purpose during and beyond the guarantee period. There has been no fundamental breach.

Circumstances where the court finds that a contractor has committed a fundamental breach are often special in some way. For instance, if a contractor’s failure to follow instructions has been detected during construction, and the contractor persists in refusing to correct its work to comply, that can be a fundamental breach of contract. In R.F.M. Electric Ltd. v. University of British Columbia et al., the general contractor fired the electrical subcontractor, alleging fundamental breach. The trial judge said that:

it was clear that R.F.M. had failed repeatedly to comply with the electrical consultant’s directions … [and] that he intended to carry out the job his way, and, according to his view of the specifications rather than meet the requirements of the electrical consultant.

The court concluded that such non-compliance constituted a fundamental breach of the contract.

Some specifications may be sufficiently important that failure to follow them is not an ordinary breach of contract, but a fundamental breach. In Lau et al. v. 1755 Holdings the plaintiffs agreed to purchase condominium units in a project the defendant was building, based on drawings and models in the defendant’s presentation centre. The actual units had several differences from the drawings and models. In each unit, several windows were deleted, leaving rooms, such as the kitchens, without any windows. The heating system was changed from a hot water system to electric baseboards. The trial judge and the Court of Appeal agreed that the missing amenities, particularly the windows, were “pertinent, germane, or essential to the bargain that these parties struck”. Failure to provide them constituted a fundamental breach of contract. The Court of Appeal noted that:

… there is a substantial difference between a piece of machinery that can be repaired or some other item of commerce [as in Hunter v. Syncrude] and a residence where someone is going to move in and live and hopefully to enjoy it. We are all entitled to some preferences in the ambiance in which we live and I think windows and heating are of particular importance.

When Is It Unconscionable to Enforce an Exclusion Clause?

If there are few construction cases where a party has successfully claimed a fundamental breach, there are even fewer dealing with enforceability of Exclusion Clauses in the face of a fundamental breach.

Williamson Bros. Construction Ltd. v. British Columbia is one. Here the trial judge found that it would be unconscionable to uphold an Exclusion Clause that forbade extra compensation for adverse site conditions on a project that involved extracting rock from a quarry. The adverse site condition was the presence of residual nitro-glycerine, which no reasonable investigation would have revealed, although the owner had received information of potential nitro-glycerine in the quarry that it did not disclose to bidders. The trial judge called the owner’s conduct “reckless disregard for the lives and safety of the workers”.

While not strictly a construction case, Celebre v. 1082909 Ontario Ltd. (c.o.b. Amerispec Inspection Services) is a recent instance where the court tackled the issue of unconscionability squarely and concluded it would be unconscionable to enforce an Exclusion Clause in the face of a fundamental breach. The case concerned a poorly-done home inspection. The Celebres bought a resale house in Nobleton, Ontario, conditional upon a satisfactory home inspection, which they hired Amerispec to conduct. After moving in, they discovered prior water damage in the basement that cost them $9,149 to fix.

They sued Amerispec in Small Claims Court. The trial judge agreed that Amerispec was negligent because:

there was moisture on the walls. I find that, having observed moisture on the walls, the inspector should have proceeded further by either using a moisture meter or some other means and consequently there was gross negligence on behalf of the defendant.

Despite that finding, Amerispec must have felt confident at trial, because it had a trump card: the contract, which contained an Exclusion Clause that limited Amerispec’s liability to the amount of its fee. That same defence had already worked for Amerispec in a previous case.

In Celebre, however, the appeal judge found that Amerispec’s breach was a fundamental breach. The Celebres wanted “a competent inspection” to allow them to “decide to accept the purchase as written, bargain for a price reduction if defects were found, or abandon the purchase altogether”. Because of Amerispec’s negligent inspection, the Celebres “did not receive the only thing they bargained for”.

He applied the test from Hunter v. Syncrude to determine whether “it was fair and reasonable to enforce the clause in favour of the party who had committed the breach. … In particular, the circumstances surrounding the making of a consumer standard-form contract could permit the purchaser to argue that it would be unconscionable to enforce an exclusion clause”:

• the contract is a consumer standard-form, a contract of adhesion, where the consumer does not negotiate the terms;
• typically there is a limited time allowed in the contract of purchase and sale for the buyer to have a home inspection done;
• the buyer does not normally have time to schedule a second inspection if he does not want to accept the inspector’s terms;
• in this case, Amerispec did not present the contract for signature or explain it until after inspecting the entire exterior.

The practice of partially performing the inspection before presenting the contract was “not a fair one”. Rather, “if there are particularly onerous terms in a contract of adhesion, the duty of the inspector is to explain the term at a time and in a manner that gives the customer a real opportunity to refuse”.

Tercon Contractors Ltd. v. British Columbia

Tercon Contractors Ltd. v. British Columbia (Transportation and Highways) is a construction case with the potential to make the doctrine of fundamental breach and unconscionability of widespread application in the construction industry.

This case did not deal with whether a contractor’s deficient performance of its work constituted a fundamental breach. Rather, it concerned whether an owner’s acceptance of a non-compliant bid was a fundamental breach of the obligation that the Supreme court of Canada first identified in 1981 in R. v. Ron Engineering and confirmed in 1999 in M.J.B. Enterprises v. Defence Construction (1951) Ltd., namely its “qualified obligation [under Contract A] … to accept the lowest tender”.

If the Supreme Court of Canada upholds the British Columbia Court of Appeal’s judgment in Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), owners will be able to avoid the substantial liability to unsuccessful bidders for breach of Contract A that they have been exposed to since Ron Engineering.

The facts of the case are simple. Tercon was an unsuccessful bidder. The successful bid was non-compliant. By accepting it instead of Tercon’s, the owner, the Province of British Columbia, breached its Contract A with Tercon. The trial judge awarded Tercon damages of $3,293,998. In doing so, the trial judge rejected the Province’s defence that an Exclusion Clause in the R.F.P. relieved the Province of liability. It read:

… no Proponent shall have any claim for any compensation of any kind whatsoever, as a result of participating in this RFP, and by submitting a proposal each proponent shall be deemed to have agreed that it has no claim.

The trial judge refused to enforce the Exclusion Clause, saying it would be unconscionable to do so:

In the circumstances here, it is neither fair nor reasonable to enforce the exclusion clause. Although both parties are sophisticated, it could not have been contemplated that there would be no recourse if the [Province] accepted a non-compliant bid: to suggest otherwise would change the base of the tender system without notice. Enforcement of the exclusion clause … would render the duty of fairness that underlies the dealings between the owner and bidder meaningless.

The Court of Appeal disagreed, saying:

…. it is difficult to say that it would be unconscionable, unfair or unreasonable to enforce the bargain between sophisticated parties on a roughly equal footing.

… to the extent the clause excuses acceptance of non-compliant bids, the public interest in an orderly and fair scheme for tendering in the construction industry is thwarted. This is a valid point. In my opinion, however, the answer lies not in judicial intervention in commercial dealings like this but in the industry's response to all-encompassing exclusion clauses. If the major contractors refuse to bid on highway jobs because of the damage to the tendering process, the Ministry's approach may change. Or, the industry may be prepared to accept that the Ministry wants to avoid suits for contract A violations, and the contractors will continue to bid in the hope that the Ministry acts in good faith.

Thus there are two issues squarely before the Supreme Court of Canada:

1. the general issue of the appropriate test to determine whether an Exclusion Clause will be enforced in the case of a fundamental breach; and
2. whether it is, as a matter of business practice, or public policy, unconscionable to tell bidders that they have no claim for damages if an owner breaches Contract A by awarding the project to another contractor.

The answer to the second question is of particular interest to those in the construction industry, because it has the potential to eliminate an enormous amount of the gamesmanship and litigation that has pervaded the bidding process over the last 30 years.